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When Massachusetts Rep. Barney Frank, a Democrat, began calling for the closure of Fannie Mae and Freddie Mac last year, it signaled the beginning of the end of the two mortgage giants. But Frank, the former patron saint of the two so-called government-sponsored enterprises, has done nothing to start the process of shutting down the GSEs, and Congress is just now starting to address the issue.

In Guaranteed to Fail, a quartet of New York University professors from its Stern School of Business focus on the "debacle of mortgage finance" that Fannie and Freddie helped create, and offer a plan for reform. In clear language, and with plenty of data to support their arguments, the authors provide a concise but comprehensive history of the GSEs—which alone makes their book worth reading.

Guaranteed to Fail

They also demonstrate that Fannie and Freddie were indeed "guaranteed to fail" when they were launched as semi-private government-sponsored enterprises four decades ago. "If the government was Doctor Frankenstein," they write, "surely the GSEs were its monster. Born of a well-intentioned…goal of creating liquidity in the secondary mortgage market, these institutions morphed into typical profit-making firms with an important exception—the government served as the backstop for the majority of their risks." The lethal combination created moral hazard—risky behavior by institutions insulated from the consequences of that risk.

Government guarantees created an unstable mortgage market, underpricing risk and driving excessive investment in housing and mortgage-backed securities. The GSEs became a major cause of the housing bubble and subsequent economic collapse, with the resulting bailout costing taxpayers $150 billion so far—a tab likely to climb much higher.

It's surprising, then, that the NYU professors end up arguing for a hybrid mortgage-finance system anyway, where the government continues to provide the majority of guarantees. Their proposal includes winding down Fannie and Freddie, and replacing them with a government agency that will be set up to provide capital to private mortgage insurers. In this system, financial institutions that package mortgages as securities would have to purchase insurance from a private guarantor, but most of the capital supporting that insurance would come from the government.

The authors attempt to get around the inability of government to price risk properly by having the private mortgage insurers set the price of insurance, with the government agency collecting fees for its support, based on that price. To try to protect taxpayers, only mortgage-backed securities with sound underwriting standards would be eligible for government-supported insurance.

Now, as hybrid plans for reforming Fannie and Freddie go, this is one of the best. Far worse proposals include nationalizing mortgage lending completely, or allowing the big banks to take over all mortgage lending by regulatory fiat. But one big flaw is that their plan does not meet the authors' own goals for reform.

They define an efficient housing-finance system as one that does not engender moral hazard, corrects market failures, limits concentrated risk and allows the market to appropriately price risk. But it is in the nature of government guarantees to promote the underpricing of risk, since their fundamental goal is to encourage more investment than would otherwise occur.

While this system may spread risk around effectively, it would still not be priced correctly. There is no way private guarantors will offer the correct price for their risk knowing that as much as 75% of their capital is coming from Uncle Sam. Investors may have the incentive to perform more due diligence, since they would not be 100% guaranteed if the private guarantor became insolvent—and they would still have taxpayer support, which would distort their investment decisions.

The authors acknowledge this problem—which is one reason they propose that the guarantee system be wound down after 10 years. But this seems politically naive. Programs like this do not disappear easily in Washington, where many things can change, often for the worse.

If the political debate over housing finance reaches an impasse where a guarantee system is inevitable, then this proposal deserves a hearing. But there are better ways to reform the market for housing finance. Still, as diagnosis rather than prescription, Guaranteed to Fail succeeds as valuable reading.

Beyond the Data

Heeding gut feelings

Reviewed by Michael Santoli

Jason Apollo Voss believes most investors think too much. Or more to the point, he believes they think too much with only part of their brains, the left half. They rely too much on linear logic, extrapolate too freely the facts from the past into an unknowable future, and collect too much data without knowing which of it is salient to an investment decision.

A former manager of the Davis Appreciation growth mutual fund—where he compiled a strong record before retiring from professional investing in 2005—Voss offers here a guide for investors to mobilize the softer emotional and perceptive powers that reside in the so-called right brain.

The Intuitive Investor

That's a lot of adjectives, which, taken together, promise grand and specific examples in evidence. The book does not always deliver on these promises. And to get to the useful parts, it's necessary to trudge through plenty of New Age riffs on our oneness with infinity and the efficacy of meditation. Not every investment book, for instance, would counsel, "The secret to understanding the universe is accepting paradox," and then footnote it like this: "Received via meditation on March 6, 2005 in Santa Fe, New Mexico, USA."

Time-pressed readers could limit themselves to a third of the book (a high batting average for a book that teaches): Chapters 1, 2, 5, 8 and 14. They admirably explain why investors need to understand their own temperaments, to be aware of the ways that adverse or favorable results affect one's decision-making—and to be sensitive to nonquantitative signals from management and the broader business climate.

"Because emotions distort the clear signals communicated by the intuitive, feeling self, it is important that you gain consciousness about your emotions. This allows you to short-circuit their operation." He goes on to offer exercises such as writing a brief autobiography and then scrutinizing it for emotional resonance. This gives a fair sense of Voss' habit of making airy assertions followed by rather mundane suggestions on how to achieve his ideal.

In the author's real-world illustrations of what he means, we can get some sense of the potential benefits that come from staying attuned to more subjective ways of discerning value. He writes of owning AIG shares while at Davis Appreciation, and having a bad feeling about CEO Hank Greenberg's eccentric Napoleon complex in running the company, which always suspiciously turned out flawless financial reports in those days. However, he concedes that he didn't give enough weight to his educated gut feeling about Greenberg, and his shareholders were the worse for it.

Voss also offers an updated spin on the Joe Kennedy observation that when shoe-shine boys start offering stock tips, it's time to get out of the market—inspired by an especially childish billboard he saw in San Francisco for a marginal dot-com business, this near the height of the Internet bubble. He mostly avoided tech stocks from that moment on in his fund.

In a particularly effective thought experiment, Voss asks readers to imagine that a cousin has asked for financial backing to buy a diner. The questions one would likely ask are mostly of the "soft" variety: Is this cousin a hard worker, trustworthy, capable of managing stress, adaptable to changing business conditions? Voss would not ask, he says, such questions as "What is the moving average price of coffee shops sold over the last 270 days?" or "Have the prices for coffee shops gone up dramatically over the last three weeks?"

The author's program should not be confused with the field of behavioral finance, which is the study of the hardwired cognitive tendencies in humans that lead to certain biases and blind spots in their economic behavior. Voss notes that the left brain is best at evaluating past facts. But there's no such thing as a future fact, so other tools are needed to make decisions about the investment future—hence, he aims for "higher refinement of the right brain."

Indeed, Voss is aiming at something like the opposite of behavioral finance—a way to exploit what elsewhere is called "emotional intelligence" in the service of sound investment strategies. Not all investment success comes by way of a spreadsheet.

Bad Do-Gooders

Making markets emerge

Reviewed by Magatte Wade

Ann Bernstein, head of a think tank in South Africa called the Centre for Development and Enterprise, unapologetically argues in this useful book that business is the greatest force for good in the developing world. She also provides a valuable critique of the corporate-responsibility movement—which she sees as an obstacle to the good that business can do.

Bernstein exposes the hypocrisy of nongovernmental organizations, which are often hostile to capitalism and consumer goods, yet which are run and financed by people who have an abundance of both. For instance, she reports how International Rivers Network, a small Berkeley, Calif., NGO, managed to hijack a World Bank commission on dam-building, by making sure that the World Commission on Dams was dominated by NGOs that were against dams—rather than developing world representatives who, most likely, would have wanted the dams for electricity and flood control. Thus do the comfortable citizens of Berkeley deny poor Africans crucial services. And after showing how appeasing the NGOs only encourages them to increase their demands, Bernstein exhorts businesses to have the courage of their convictions and to avoid giving in. Wisely, she encourages companies to seek allies who understand their positive impact.

The Case for Business In Developing Economies

Unfortunately, The Case for Business in Developing Economies focuses exclusively on the case for multinational corporations, rather than on business as broadly defined under free competition. I was hoping to read about the problems local entrepreneurs face setting up businesses in the developing world. Most African nations are dramatically overregulated, making it extremely difficult for indigenous entrepreneurs to create companies. Thus, the book fails to call attention to the most important way in which business can be re-branded as a positive influence in developing nations.

A key branding problem with business in Africa and elsewhere is that it all too often involves outsiders hiring natives to fill only the lowliest posts. What no one calls attention to is the fact that governments of developing nations make it prohibitively expensive to start legal businesses. The result: Only multinationals can afford the red tape.

There are exceptions. But most locally owned businesses in these countries of any significance are crony-capitalist enterprises in which a friend of the government obtains a monopolistic concession. These deals often lead the indigenous population to despise business—when, in fact, they should be despising their governments for preventing free competition from taking place.

A book that moved beyond a defense of corporations to illustrate the tenacity of entrepreneurs would have been more effective at amping up the reputation of capitalism.

Senegalese entrepreneur MAGATTE WADE, founder of Adina World Beverages, writes for the Huffington Post. She blogs at magatte.wordpress.com.